micro-ch01-principles of economics

MICROECONOMICS CHAPTER 1 10 PRINCIPLES OF MICROECONOMICS INSTRUCTOR MAIDA KHURRAM RECOMMENDED BOOK: Principles of Microeconomics by N. Gregory Mankiw TEN PRINCIPLES OF ECONOMICS 0.

In this chapter, look for the answers to these questions:  What kinds of questions does economics address?  What are the principles of how people make decisions?  What are the principles of how people interact?  What are the principles of how the economy as a whole works? 1.

DEFINITION  Microeconomics is the social science that studies the implications of incentives and decisions and how they affect the utilization and distribution of resources on an individual level TEN PRINCIPLES OF ECONOMICS 2.

TEN PRINCIPLES OF ECONOMICS 3 What Economics Is All About  Scarcity: the limited nature of society’s resources  Economics: the study of how society manages its scarce resources, e.g.  how people decide what to buy, how much to work, save, and spend  how firms decide how much to produce, how many workers to hire  how society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs.

The principles of HOW PEOPLE MAKE DECISIONS.

TEN PRINCIPLES OF ECONOMICS 5 HOW PEOPLE MAKE DECISIONS All decisions involve tradeoffs. Examples:  Going to a party the night before your midterm leaves less time for studying.  Having more money to buy stuff requires working longer hours, which leaves less time for leisure.  Protecting the environment requires resources that could otherwise be used to produce consumer goods. Principle #1: People Face Tradeoffs.

TEN PRINCIPLES OF ECONOMICS 6 HOW PEOPLE MAKE DECISIONS  Society faces an important tradeoff: efficiency vs. equality  Efficiency: when society gets the most from its scarce resources  Equality: when prosperity is distributed uniformly among society’s members  Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.” Principle #1: People Face Tradeoffs.

TEN PRINCIPLES OF ECONOMICS 7 HOW PEOPLE MAKE DECISIONS  Making decisions requires comparing the costs and benefits of alternative choices.  The opportunity cost of any item is whatever must be given up to obtain it.  It is the relevant cost for decision making. Principle #2: The Cost of Something Is What You Give Up to Get It.

TEN PRINCIPLES OF ECONOMICS 8 HOW PEOPLE MAKE DECISIONS Examples: The opportunity cost of… …going to college for a year is not just the tuition, books, and fees, but also the foregone wages. …seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. Principle #2: The Cost of Something Is What You Give Up to Get It.

TEN PRINCIPLES OF ECONOMICS 9 HOW PEOPLE MAKE DECISIONS Rational people  systematically and purposefully do the best they can to achieve their objectives.  make decisions by evaluating costs and benefits of marginal changes – incremental adjustments to an existing plan. Principle #3: Rational People Think at the Margin.

TEN PRINCIPLES OF ECONOMICS 10 HOW PEOPLE MAKE DECISIONS Examples:  When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education.  When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue. Principle #3: Rational People Think at the Margin.

TEN PRINCIPLES OF ECONOMICS 11 HOW PEOPLE MAKE DECISIONS  Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment.  Rational people respond to incentives. Examples:  When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs.  When cigarette taxes increase, teen smoking falls. Principle #4: People Respond to Incentives.

You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” In each of the following scenarios, should you have the transmission repaired? Explain. A. Blue book value is $6500 if transmission works, $5700 if it doesn’t B. Blue book value is $6000 if transmission works, $5500 if it doesn’t A C T I V E L E A R N I N G 1 Applying the principles 12.